BY:

Matt Begnaud

Tom Davies

Deputy Head of Marine and Energy Liability, Aspen Insurance

October 19, 2018

Innovation Brings New Challenges to the Upstream Oil Sector

Despite the challenges it faces, ultimately, the oil and gas industry is nimble and “turning right,” to use an industry colloquialism. If you are a retail insurance agent interested in placing business in this booming sector, it is important to have a good wholesale insurance partner. To limit your exposure to errors and omissions allegations, work with a group that provides the right product for your insured’s needs. Since each of your insureds has their own unique exposures, underwriting bench strength is critical to build the right solution for each account’s needs.

Increased Costs of Pollution Cleanups Problematic

In a more connected world with a sharp focus on issues affecting the environment, the spotlight of corporate good citizenship has shined on the oil and gas industry over the last decade. Oil spills and the fear of fracking have provided headlines for the media following incidents that previously would have garnered less attention.

Additionally, the costs associated with pollution cleanup have steadily increased over the past 25 years. A recent event in 2015 cost roughly $60,000 a barrel for cleanup, up 345 percent from the 1989 Exxon Valdez cleanup costs at roughly $13,462 a barrel. The social responsibility aspect as well as higher financial penalties created positive change in the industry. Members of the boardrooms for oil and gas lease operators must go to great lengths to ensure they protect the environment, thus avoiding public scrutiny as well as regulatory fines.

With the increase in cleanup costs comes a need for increased liability limits. Advanced cleanup levels are required today due to a higher public standard for environmental cleanliness. Upstream onshore operators must contemplate and factor in these costs when they are selecting liability limits. Limits purchased a decade ago will not suffice in today’s market.

The Impact of a Connected World and an Aging Infrastructure on Cleanup Costs

A severely aging infrastructure burdens the oil and gas industry. According to a recent survey published by Oracle, half of the oil and gas maintenance projects arise from aging infrastructure. There are 2.5 million miles of pipelines that cross state lines that a variety of companies manage. The industry installed seventy percent of these pipelines in the 1950s, 1960s and 1970s. As pipelines age, “…eventually they are going to spill,” according to Tony Iallanardo of the National Wildlife Federation in a 2012 Scientific American article. “They’re ticking time bombs,” he added.

While oil pipelines are safer than trucks, they transport only a fraction of oil shipments. However, when pipelines do fail, the results can be catastrophic. Leaks and ruptures occur frequently, and experts warn that, as already aged pipelines grow older, accidents will only increase. Between 2000 and 2012, gas explosions killed 116 people.

Innovations in oil cleanup have also increased the cost of remediation. To avoid using chemical dispersants to clean crude and other spills, researchers are focusing on new technologies to improve leak and spill management. From smart filter technology to mixing water-repellent ferrous nanoparticles into oil spills then using magnets to remove the oil from water, these innovations may increase costs yet help upstream producers respond to an increasingly alert public.

Claims Costs Drive the Need for Increased Liability Limits

A January 2018 explosion in Oklahoma, a ‘blowout,” was cited as one of the deadliest onshore drilling accidents in years. Five workers died and many more were injured. Right after the explosion, the Oklahoma Supreme Court struck down a workers’ compensation law, ruling that gas and oil workers could sue oil and gas companies for their injuries. Whether or not this case holds up if the oil company makes an exclusive remedy argument remains to be seen. The point is that society and our court systems seem to have shifted toward a more pro-employee stance, which in turn will increase claim costs.

Challenges abound in the upstream oil and gas sector. In a recent book by former president of Shell Oil John Hofmeister, entitled Why We Hate the Oil Companies, Hofmeister tackles America’s disdain for big oil. This contempt can translate into larger jury verdicts based on jurors’ opinions about the oil industry.

This industry is not the only industry impacted by rising claims costs, however. The rising cost of medical care and more innovation and testing in healthcare continues to drive claim costs much higher than the average rate of inflation.

This translates into larger special damages and bigger compensatory awards. Legal costs, too, are rising. The public is well aware of large claims payouts and the internet and social media only increases that awareness.

The average rate of inflation in the US is two percent. However, between 2000 and 2018, medical costs increased an average of 3.48 percent per year. From 2005 to 2013, general liability claims costs rose from an average per claim of $11,738 to $15,506, a 32.1 percent increase.

Clearly, claims values will continue to escalate. Choosing appropriate liability limits and creating coverage towers from available markets is critical to protect your clients and avoid an errors and omissions allegation.

On the bright side, we see an abundance of both primary and excess market capacity for upstream, onshore oil production. Forging a relationship with your wholesaler can ensure you tap into the currently growing market.

In Closing

The oil and gas industry is showing signs of growth not seen since oil prices crashed at the end of 2014. With oil edging up to almost $70 a barrel and demand increasing globally, the US may emerge as the world’s leading oil producer. What does this mean to insurance industry professionals?

Upstream oil and gas exploration and drilling has historically been a very challenging industry, made even more so by its boom-and-bust cycle. The challenges associated with an aging infrastructure, talent management issues, the increased costs of cleanups and rising claims costs has set the oil industry on a course toward increased corporate responsibility and a speedy response to spills and other losses.

Yet despite these challenges, the oil industry will thrive because oil is a key component to market stability throughout the world.

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